Every business hands over money to the government in the form of taxes. Everybody recognizes that paying taxes is necessary for the maintenance of services and infrastructure locally as well as on the state and federal levels. Individuals and businesses attempt to pay their fair share of taxes while at the same time taking allowable deductions. Depreciation is a permissible business tax deduction.
Depreciation is a fixed business expense. The Internal Revenue Service (IRS) allows businesses to offset the cost of newly acquired tangible assets. Businesses allocate the expenditure over a period of years. A specific dollar amount is allotted each year over the life of the depreciable asset. The cost reduction is depreciation. There are a number of systems the IRS allows for depreciating business assets. Three examples of depreciation methods are straight-line depreciation, declining-balance method and the sum-of-years' digits method.
A common method of reducing the cost, or purchase price, of assets is straight-line depreciation. This process reduces the cost of an asset by an equal amount each year over the estimated useful life of the asset, typically a number of years. Straight-line depreciation is calculated by dividing the depreciable cost of the asset by the number of years the asset will be used.
Advantages of Straight-Line Depreciation
Straight-line depreciation, also known as the fixed or equal-installment depreciation method, is the simplest and most widespread form of depreciation used by businesses. It is suitable for assets that operate uniformly and consistently over the life of the item. The fixed method is straightforward, uncomplicated, easy to understand and simple to apply. Each year the same amount of money is taken as a depreciable business expense on the company's tax return. Straight-line depreciation is suitable for less expensive items, such as furniture, that can be written off within the asset's defined legal, estimated or commercial life. The IRS sets guidelines for estimating an asset's useful life.
Disadvantages of Straight-Line Depreciation
Most pieces of office equipment, machinery and other items purchased do not perform exactly the same each year. As assets age they become less efficient. Repair costs usually increase over time. Straight-line depreciation does not account for the loss of efficiency or the increase in repair expenses over the years and is, therefore, not as suitable for costly assets such as plant and equipment. The functional life span of some assets cannot clearly be estimated. The straight-line depreciation method should not be used when the useful life of an asset is unpredictable.